Question

You have been asked to analyze the capital structure of DASA, an environmental waste disposal firm, and make recommendations on a future course of action.
DASA has 40 million shares outstanding, selling at $20 per share, and a debt/equity ratio (in market value terms) of 0.25. The beta of the stock is 1.15, and the firm currently has an AA rating, with a corresponding market interest rate of 10%. The firm’s income statement is as follows:
EBIT ................ $150 million
Interest expenses .......... $20 million
Taxable income ........... $130 million
Taxes ................ $52 million
Net income ............ $78 million
The current riskfree rate is 8%.
a. What is the firm’s current WACC?
b. The firm is proposing borrowing an additional $200 million in debt and repurchasing stock. If it does so, its rating will decline to A, with a market interest rate of 11%. What will the WACC be if they make this move?
c. What will the new stock price be if the firm borrows $200 million and repurchases stock (assuming rational investors)?
d. Now assume that the firm has another option to raise its debt/equity ratio (instead of borrowing money and repurchasing stock). It has considerable capital expenditures planned for the next year ($150 million). The company also currently pays $1 in dividends per share. If the company finances all its capital expenditures with debt and doubles its dividend yield from the current level for the next year, what would you expect the debt/equity ratio to be at the end of the next year?